Fairholme (FAIRX) circa 2011: Two sides of the coin

Bruce Berkowitz’s fund has gotten a lot of media attention lately. Investors point to significant financial sector exposure and investments in AIG, BofA, Citi and St. Joe stock in particular as a drag on the fund’s 2011 results. While admitting on the conference call that the fund’s performance this year was “horrible” and the health care position sell-off happened “too early”, Berkowitz is very consistent in his investment style (“Ignore the Crowd”) and is making pointed sector- and security-specific bets. Notably, his decision last month to potentially increase the fund’s position in St. Joe’s stock to 50% of shares outstanding (up from 30%) invited a lot of criticism from investors and the media. But what difference does it make for the fund’s performance? How do we know what portion of the fund’s results to-date are due to sector vs. security bets?
Similar to our previous posts on Fairholme we will perform a back-of-the-envelope returns-based style analysis of the fund’s daily NAVs to understand the fund’s exposures to major economic sectors represented by S&P 500, MSCI and DJ indices. The results of the analysis performed using mpi Stylus Pro ™ are shown in the figure below.

Even though exposures derived in such an analysis should not necessarily coincide with holdings information (after all, we use only the fund’s NAV!), still the precision of the analysis is remarkable. The analysis shows the major exposure to Financials, peaking over 70% earlier in the year. Note that the fund is fully invested, confirmed recently in a Berkowitz interview. What’s interesting, though, is that the fund’s exposure to Real Estate in September has almost tripled since sector data was last available four months ago. Another significant exposure of the fund is to International Stocks (incl. Emerging Markets). Given that all three segments (Financials, Real Estate and Emerging Markets) took a dive during the course of year, it wouldn’t be surprising if just these exposures alone could have impacted the fund’s performance in a negative way. The figure below quantifies this in an intuitive way.

Year-to-date the fund underperformed the S&P 500 Index by 23.8% (Excess) with almost two-thirds due to sector bets (Timing) and the rest attributed to poor security picks such as AIG or St. Joe’s (Selection). Yet another reminder that any buy/sell transaction has at least two sides to it and in the case of Fairholme investors seem to focus their energy primarily on the least important one. And it’s remarkable how much information could be gleaned from publicly available performance data using delicate quantitative analysis.